The ECB’s commitment to extra loose monetary policy through forward guidance and QE has resulted in the euro to becoming one of the darlings of the funding currencies. US corporates such as Nike, Apple and Coca-Cola have taken advantage of a weak euro to raise the currency for use in their European operations – in so doing they shield themselves from further declines in the euro against the dollar. Deals from US firms raising money in euros are at historic highs.
This is one of the manifestations of the euro’s new funding currency status. In general, Europe’s current account surplus is being recycled by the banks through the capital account. Also, foreign investors buying European assets have been hedging their FX exposure. It is this hedge-based long in the euro that means it is behaving very much like the yen in the years leading up to the crisis. As the below chart shows, the correlation between the yen and the Nikkei went firmly negative in 2006-07.
This is similar to the euro’s relationship with domestic stocks over the last year.
Like the yen in the years after 2007, this means the euro is more likely to strengthen through risk-off periods, as investors find themselves over-hedged. However, in larger risk-off scenarios the euro should still fall, as asset-selling overwhelms hedging activity.